How to Take a Loan Out on Your Life Insurance

Certain types of life insurance policies allow policyholders to access funds through a policy loan. These loans enable individuals to tap into the accumulated cash value within their policy, providing liquidity without surrendering the policy or its death benefit. Unlike traditional bank loans, policy loans do not typically involve a credit check or a lengthy approval process.

Eligible Life Insurance Policies

Not all life insurance policies accrue cash value, a fundamental requirement for a policy loan. Term life insurance, for instance, provides coverage for a specific period but does not build a cash component, making it ineligible for such loans.

Policies that do accumulate cash value and are therefore eligible for loans include whole life, universal life, and variable universal life insurance. Whole life insurance policies offer a guaranteed death benefit and a cash value component that grows at a guaranteed rate, allowing policyholders to anticipate available loan amounts.

Universal life insurance policies provide more flexibility than whole life policies, allowing adjustments to premiums and death benefits, and their cash value growth is tied to an interest rate set by the insurer, which can fluctuate. Variable universal life insurance further introduces investment risk, as its cash value growth is linked to the performance of underlying investment sub-accounts chosen by the policyholder. While these policies offer potential for higher cash value growth, they also carry the risk of decline, which could impact the available loan amount.

Understanding Life Insurance Loans

A loan taken against a life insurance policy is not a withdrawal but a loan using the cash value as collateral. The cash value continues to earn interest or investment returns, though typically at a reduced rate while the loan is outstanding and the policy remains in force.

Interest accrues on the outstanding loan balance, and this interest is generally not tax-deductible for the policyholder. The interest rate is set by the insurance company and can be either fixed or variable, often ranging from 5% to 8% annually. Failure to pay the interest can lead to the interest being added to the outstanding loan principal, causing the loan balance to grow.

The loan principal and any accrued, unpaid interest reduce the death benefit payable to beneficiaries if the policyholder passes away before the loan is fully repaid. For example, if a policy has a $500,000 death benefit and an outstanding loan of $50,000, the beneficiaries would receive $450,000.

The Loan Application Process

Initiating a life insurance policy loan typically begins with contacting your insurance provider. Most insurers offer multiple channels for communication, including dedicated customer service phone lines, online portals, or direct mail. It is advisable to have your policy number readily available when you make contact, as this will expedite the process.

Upon contact, you will generally request a policy loan application form. This form will require basic information about the policyholder and the desired loan amount.

The completed application can often be submitted through various methods, such as uploading it via a secure online portal, mailing it to the company’s designated address, or in some cases, submitting it over the phone if the insurer has a streamlined process. Processing times can vary but typically range from a few business days to a couple of weeks, depending on the insurer’s efficiency and the method of submission. Once approved, the funds are usually disbursed directly to the policyholder via electronic funds transfer or a physical check.

Managing Your Life Insurance Loan

After securing a life insurance loan, policyholders have various options for repayment. Many policies offer flexibility, allowing for scheduled monthly payments, partial repayments, or even a lump-sum repayment at any time. It is generally not mandatory to adhere to a strict repayment schedule, providing policyholders with discretion in how and when they return the borrowed funds.

Despite the flexibility, it is important to understand the consequences of not repaying the loan. The outstanding loan balance, including accrued interest, continuously reduces the policy’s cash value and the eventual death benefit. If the loan balance, along with any unpaid interest, grows to exceed the policy’s cash value, the policy can lapse.

A policy lapse means the coverage terminates, and the death benefit is lost. Furthermore, if a policy lapses with an outstanding loan, the unpaid loan amount that exceeded the policy’s basis (premiums paid less dividends received) may be considered taxable income by the Internal Revenue Service (IRS). This taxable event can occur even if the policyholder never received the full cash value of the policy. Therefore, managing the loan diligently is important to maintain the policy’s integrity and avoid potential tax liabilities.